Ocado Group plc Proves Profit Doubters Wrong, But I’m Still Selling

The latest figures from Ocado Group PLC (LON:OCDO) confirm this Fool’s sell rating on the online retailer, despite its partnership with Wm. Morrison Supermarkets plc (LON:MRW).

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OcadoThis morning’s half-yearly results from Ocado Group (LSE: OCDO) revealed that the online grocer is finally making a profit — but having looked more closely, I wasn’t surprised to see the firm’s shares slide by nearly 5% when markets opened:

Ocado Group H1 2014 H1 2013
Sales £429.7m £355.9m
Operating profit £10.9m -£1.1m
Operating margin 2.5% n/a
Earnings per share 1.28p -0.66p

Source: Ocado Group results.

Ocado may have proved its most bearish doubters wrong — it can deliver groceries profitably, without the benefits of a nationwide store network — but despite this apparently good news, I still rate the firm’s shares as a strong sell.

Should you invest £1,000 in Ocado right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Ocado made the list?

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Can Morrisons deliver?

Ocado supporters point to the firm’s ability to grow by offering home delivery outsourcing services of the type it is now providing for Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US).

However, there don’t seem to be any other such deals in the pipeline, and the deal with Morrisons generated less than 5% of Ocado’s revenue during the last six months. In my view, it’s too early to judge the potential of this line of business.

Right company, wrong price?

Ocado reported earnings per share of 1.28p for the first half of this year, finally breaking into post-tax profitability.

Assuming the trends seen in the first half of this year continue, my calculations suggest that Ocado could report full-year earnings per share of around 2.9p, significantly ahead of recent analysts’ forecasts of 2.5p.

Despite this, Ocado’s 350p share price still equates to a prospective price to earnings (P/E) rating of 120, falling to 66 in 2015, if analysts’ forecasts that earnings will rise to 5.3p per share next year are correct.

That’s just plain bonkers in my view, as Ocado has not yet provided any proof that it can benefit from economies of scale: Ocado’s distribution costs rose by 25% during the first half of this year, even though sales rose by just 20%.

In my view, Ocado shares might be fairly priced on a forecast P/E of 25 — say around 75p. I reckon that anything more than that is just speculation.

How big is enough?

Ocado’s 2.5% operating margin is below the supermarket sector average of around 4%, and the firm’s sales would have to rise by a further 190% to match Tesco’s home delivery sales, which totalled £2.5bn last year, and generated a profit margin of 5%.

Ocado continues to invest in new capacity to fuel continued growth, but in my view the firm’s current valuation makes the online retailer uninvestable.

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland owns shares in Tesco and Wm. Morrison Supermarkets but not in Ocado Group. The Motley Fool owns shares in Tesco.

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